Opinion

Hedging threat and Venezuela Oil by Dr. Daniel Fine


How can Saudi Arabia and OPEC behind them strike a second blow against shale oil producers in the Southwest? The first was the 2014-2017 price and market share war in which they raised production to put the higher cost Americans out of business.  
This was partially abandoned at Algiers in a reversal to opt for a higher price for crude oil from $26 to the high $40 range. The marketing tool is lowering their production by 1,800,000 barrels per day.
The second blow is process.  

The Saudi Arabian Oil Ministry and its state company, Saudi Aramco, negotiated in London with Glencore (world's largest trading combined with mining), banks and hedge funds to see if they could reduce the liquidity necessary for American oil and gas shale producers to hedge forward to obtain a higher price.  
Without access at only financial transactions costs to the “strip” or the forward price of oil at at least 10 percent higher than current prices “spot,” WPX and all the Permian-Delaware significant producers would not have survived the recent downturn in their current form.

If there is no difference between the price oil today and September 2018,  which is called the “contango,” this would be a problem of liquidity – no entity taking the other side against the oil and gas producer on a contract.  No cash would be bet against the oil and gas producer who sells forward one year. One side, for example, sells 70 percent of 2018 oil production at June 2018 prices in the present while the other side buys or covers, as the counterpart, the contract.
Saudi Arabia correctly followed data which demonstrated that despite the decline in the price of oil from $100 in 2014 to a low of $26 per barrel, oil producers hedged against the fall and largely survived.  Without hedging the producers would have negative cash flows and serious problems of debt to keep going.

In the Permian-Delaware, without hedging, 60 percent of revenue in three years would have been lost to the producers and the State of New Mexico would have faced a shortfall of $4.5 billion or a fiscal collapse.
It is not certain that the financial services and traders in the London discussions would go along by raising the cost of hedging to choke off liquidity. The legality of a liquidity squeeze in the U.S. with exchanges officially regulated is a roadblock to the Saudi tactic.

The effort to target liquidity and thus the ability of oil and gas producers to hedge in New Mexico and in other states demonstrates that Saudi Arabia and OPEC will resume market aggression and for oil market share that subsided in the last several months to  capture higher prices with lower output which would benefit the Initial Public Offering of 5 percent of Saudi Aramco shares by next year.  

This outcome is part of the making of the Second Downturn in 2019 in the Four Corners and the Permian-Delaware Basins.
The Trump Administration is conducting a review of the situation of the Venezuelan dictatorship. It is considering an import ban on Venezuelan oil which involves substantial refining in the Gulf Coast and Citgo. 

Venezuelan imports were a principal part of the national energy policy in reaction to the OPEC embargo on its exports to America in 1973-74.  That policy had two parts: (1) conservation, stockpiling, and alternative fuels; (2) diversity of supply away from OPEC import dependence which is now in doubt as  a consequence of the shale oil horizontal drilling technology breakthrough in the Southwest and North Dakota.
Venezuelan crude oil is heavy sour which called for expansion of refining investment in the Gulf and East Coast to process and substitute for Middle East lighter grades.  These refiners are currently opposed an Administration rule against importing Venezuelan crude oil.

They, rightly, followed Government diversity of supply policy and provided capital outlay during the last 40 years.
This heavy sour Venezuelan investment in plant, however, disqualified them as major refiners of the five million additional barrels of West Texas Intermediate light sweet due to technology in shale recovery.
This created a bottleneck and discount in the Midland price, which led producers in Texas and New Mexico to lobby successfully against another 1970s  policy reaction to the OPEC embargo – the prohibition on exporting American crude oil.
The Administration is faced with the strategic big question. Is there need for Venezuelan heavy sour today with America having the largest oil reserves in the world, as Norway has concluded?  Venezuelan crude oil was a lowering of the risk of foreign oil denial or disruption.  It is impossible to defend it as such today when domestic oil is produced in abundance.  
America is now indifferent to OPEC supply disruption. We are beginning to sell off the Strategic Petroleum Reserve, the other “insurance” policy.  It, too, is not needed for that purpose.
Finally, the three New Mexican oil refineries, including the 26,000 barrel capacity at Gallup, use heavy oil only for blending purposes with light, and they obtain it from Canada.  
Inland refiners can obtain small and limited quantities in North America for blending. They need not import or buy Venezuelan heavy sour crude. The East and Gulf Coast refiners could pursue incentives, if needed, to
convert to light crude supply from the Southwest and North Dakota and end imports from Venezuela.
Oil import control and suspension is supported by Harold Hamm, who led producers against the OPEC embargo policy response that denied exports of domestic crude until 2015.  
He advises President Trump on Oil and Gas.  As head of Continental Resources, he is consistent. In 1999, He led a petition with New Mexico producers and its Washington elected officials to reduce or suspend foreign oil import.
Imports of foreign oil is now a matter of case-by-case action leaving the future with respect to Saudi Arabia and OPEC open. 
President Trump will consider the Venezuela refugee impact on Florida along with his preference to lower foreign intervention and pursue an America First policy.
Daniel Fine is the associate director of New Mexico Tech's Center for Energy Policy. The opinions expressed are his own.


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